Taxation of Gamblers: the House Always Wins
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Oklahoma Law Review Volume 70 Number 3 2018 Taxation of Gamblers: The House Always Wins Christine Manolakas Follow this and additional works at: https://digitalcommons.law.ou.edu/olr Part of the Gaming Law Commons, Taxation-Federal Commons, and the Tax Law Commons Recommended Citation Christine Manolakas, Taxation of Gamblers: The House Always Wins, 70 OKLA. L. REV. 553 (2018), https://digitalcommons.law.ou.edu/olr/vol70/iss3/1 This Article is brought to you for free and open access by University of Oklahoma College of Law Digital Commons. It has been accepted for inclusion in Oklahoma Law Review by an authorized editor of University of Oklahoma College of Law Digital Commons. For more information, please contact [email protected]. OKLAHOMA LAW REVIEW VOLUME 700000000000000000 SPRING 20180000000000000000 NUMBER 3 TAXATION OF GAMBLERS: THE HOUSE ALWAYS WINS CHRISTINE MANOLAKAS* Abstract Gambling is everywhere. Whether it takes place in a casino, on the internet, or even on a cell phone, there is no shortage of venues for the avid gambler. With the rapid expansion and geographical spread of gambling activities in the United States and abroad, gamblers must understand the tax consequences of their gaming. For the professional, expenses incurred in his or her occupation are deductible but, like losses from wagering transactions, are limited to wagering gains. Recreational gamblers can also deduct wagering losses to the extent of gains, but expenses incurred in pursuit of their pastime (or compulsion) are nondeductible personal expenses. Explored in this Article are such topics as the computation and characterization of wagering gains, the treatment of cancellation of gambling indebtedness, the deductibility and substantiation of wagering losses, the classification and taxation of professional and amateur gamblers, the use of other tax entities to maximize the wagering loss deduction, and the deductibility of the cost of charity lotteries and raffles. This survey of tax laws and procedures as they relate to gamblers is designed to inform such risk takers of the tax consequences of their wagering activities and to encourage both professional and casual gamblers to keep detailed, contemporaneous records of their wins and * Christine Manolakas is a Professor of Law at the University of the Pacific, McGeorge School of Law, Sacramento, California. The author would like to thank her research assistants, Anam W. Hasan, Nicholas A. Kanakis, Jasmine Sandhu, and Charles A. Wiseman, for their valuable contributions. This Article went to press shortly after enactment of the Tax Cuts and Jobs Act of 2017. The resulting changes in tax law related to the taxation of gamblers are reflected. 553 Published by University of Oklahoma College of Law Digital Commons, 2018 554 OKLAHOMA LAW REVIEW [Vol. 70:553 losses. If a gambler is unlucky, the Internal Revenue Service will reconstruct gambling income, disallow wagering losses, and—if the gambler is very unlucky—impose a multitude of tax penalties. Table of Contents I. Introduction ........................................................................................... 554 II. Inclusion of Wagering Gains into Income ........................................... 556 A. Computation of Wagering Gains ..................................................... 558 B. Characterization of Wagering Income ............................................. 560 C. Reconstruction of Wagering Income ............................................... 561 D. Cancellation of Gambling Indebtedness .......................................... 564 E. Civil and Criminal Penalties ............................................................ 567 1. Civil Penalties .............................................................................. 568 2. Criminal Penalties ........................................................................ 572 III. Deduction of Wagering Losses ........................................................... 575 A. Wagering Transactions Defined ...................................................... 576 1. Sweepstakes, Raffles, and Lotteries ............................................. 577 2. Comps .......................................................................................... 577 3. Tokes ............................................................................................ 578 4. Game-Show Expenses .................................................................. 578 5. Shills ............................................................................................. 579 6. Thefts ............................................................................................ 579 B. Necessary Documentation ............................................................... 580 C. Involvement of Other Tax Entities .................................................. 583 IV. Deduction of Gambling Expenses and Losses .................................... 584 A. Business of Gambling ...................................................................... 585 B. Tax Treatment of Professional Gamblers ........................................ 589 C. Tax Treatment of Recreational Gamblers ........................................ 594 D. Deduction of Charitable Contributions ............................................ 597 V. Conclusion ........................................................................................... 599 I. Introduction Gambling is apparently as old as the human race. The practice runs back through recorded history until it is lost amid the mysteries of tradition. It affects people in all latitudes, longitudes 1 and stages of civilization. 1. Skeeles v. United States, 95 F. Supp. 242, 242 (Ct. Cl. 1951). https://digitalcommons.law.ou.edu/olr/vol70/iss3/1 2018] TAXATION OF GAMBLERS 555 “Legal gambling is a multi-billion-dollar industry that has proliferated across the country and has become a major source of adult entertainment.”2 In 2016, the U.S. gaming industry generated $73.1 billion in revenue, marking the seventh consecutive year of growth for the overall industry and the second time the industry surpassed $70 billion in total gaming revenue.3 The U.S. commercial casino gaming segment of the industry generated a record $38.7 billion in revenue with 581 casinos across twenty-four states.4 While only three states have legalized online gaming, the iGaming segment of the industry generated $212.2 million in revenue in 2016, the third full year of gaming operations.5 Tribal gaming generated an estimated $30.7 billion in revenue marking the seventh consecutive year of growth in that segment of the industry.6 Limited stakes gaming, representing gaming machines at taverns, restaurants, and travel centers, generated $3.5 billion in revenue in 2016.7 With such dramatic growth of the gaming industry, the tax consequences to an individual, whether visited or abandoned by Lady Luck, must be examined. This Article explores the tax treatment of gamblers: professional gamblers, who are engaged in the trade or business of gambling, and recreational gamblers, who are not. Both professional gamblers and recreational gamblers must include gambling winnings in income for tax purposes, raising issues as to the methods used for the computation of wagering gains by gamblers and the reconstruction of wagering gains by the Internal Revenue Service (I.R.S. or Service). The characterization of gambling winnings and the cancellation of gambling indebtedness has recently generated conflicting results among the courts, thus warranting discussion. Penalties, both civil and criminal, which often attach to the under-inclusion of gambling income and the over-statement of gambling losses, are also examined. Internal Revenue Code (I.R.C.) § 165(d) states that losses from “wagering transactions” are deductible only to the extent of gains from “wagering transactions.” Thus, identifying the types of activity that constitute wagering transactions is a threshold question. As to both gains and losses from wagering transactions, contemporaneous documentation is 2. Libutti v. Comm’r, 71 T.C.M. (CCH) 2343, 2343 (1996). 3. 2017 Gaming Statistics, RUBINBROWN 3 (Apr. 1, 2017), http://www.rubinbrown. com/Gaming_Stats.pdf. 4. Id. at 3. 5. Id. at 5. 6. Id. at 4. 7. Id. Published by University of Oklahoma College of Law Digital Commons, 2018 556 OKLAHOMA LAW REVIEW [Vol. 70:553 unequivocally necessary. This Article reviews guidelines established by the Service and courts for keeping the necessary books and records to substantiate wagering gains and losses. Further, the successful use of other tax entities by taxpayers to maximize the deduction of wagering losses is also discussed. The distinction between professional gamblers and recreational gamblers becomes pivotal in the computation of the gambler’s taxable income. Distinguishing between professional and recreational gamblers is a factual determination, aided by court decisions and Treasury regulations. Although wagering losses are limited to wagering gains, a professional gambler can also deduct gambling-related expenses incurred in the business of gambling to the extent of wagering gains. Nonprofessional gamblers are limited to the deduction of gambling losses to the extent of gains, which are treated as itemized deductions. Finally, the Article examines whether purchasers of lottery or raffle tickets may claim a charitable contribution deduction. II. Inclusion of Wagering Gains into Income Gross income includes income “from whatever sources derived.”8 Thus, gains realized